An alternate perspective that I sometimes use is to view the crash as a short squeeze.
Going into debt is equivalent to selling short a currency. It’s usually safer than shorting a stock, because currencies are designed so that their value is stable, rather than to usually go up.
Just like someone who owes GameStop shares needs to have the ability to buy back those shares, a player in debt needs the ability to regain dollars.
There are important limits to how many dollars one can safely owe, and it depends a fair amount on how other traders of dollars behave.
If one big player, or many little players, misjudge their risks, they need to acquire more dollars. Sometimes everything works out fine because lenders are optimistic enough to lend more. Sometimes big players expect things to work out poorly, and that causes them to compete for drive up the price of dollars (as they would drive up the price of GameStop) in order to cut their risks. Guesses about what others will do can play a key role here, which is part of why the result is hard to predict.
One somewhat unique feature of modern currencies is that central banks are at least nominally able to supply unlimited quantities of them, and there are widespread expert opinions that they out to do roughly that when the value of the currency is being bid up (i.e. when there’s deflation). There’s some sign of a trend towards central banks doing better at that. But it’s still not obvious what’s preventing them from doing better. (This is mostly relevant to standard recessions, which are caused by an unexpected decline in the inflation rate; some debts can’t be handled by stabilizing the currency, so I’m a bit hesitant to accept your broad framing of the term debt crises).
In the ending parenthetical, it sounds like you’re saying that I’m overapplying the term “debt crisis” compared to “standard recession” because what-you-would-call-a-standard-recession is caused by a quick decline in inflation, whereas what-you-would-call-a-debt-crisis is merely sparked by or correlated with a quick decline in inflation and is sometimes inflationary. Is that a correct paraphrase?
I will think about that claim more, but for now your frame seems very compatible with mine to me. My current reconciliation would say that your frame is more elegant for describing how the liquidity crunch works (just like a short squeeze on cash once people start bidding it up as they trade in debt, with an emphasis on the primacy of other actors’ reactions), but that it doesn’t really capture how you get to that vulnerable point, which is usually not by huge inflation moves but via the debt/credit cycle and some bad debts that take a bunch of cash out of the economy at once.
That paraphrase is mostly good. I’m trying to separate monetary phenomena, which are the main problem in recessions, from reckless debt levels, which are the main contributor to government debt crises.
Yes, my explanation is mostly compatible with yours.
I didn’t try to explain how a system becomes vulnerable. I think that happens via recency bias causing misjudgments, plus competitive pressures that Romeo mentions.
An alternate perspective that I sometimes use is to view the crash as a short squeeze.
Going into debt is equivalent to selling short a currency. It’s usually safer than shorting a stock, because currencies are designed so that their value is stable, rather than to usually go up.
Just like someone who owes GameStop shares needs to have the ability to buy back those shares, a player in debt needs the ability to regain dollars.
There are important limits to how many dollars one can safely owe, and it depends a fair amount on how other traders of dollars behave.
If one big player, or many little players, misjudge their risks, they need to acquire more dollars. Sometimes everything works out fine because lenders are optimistic enough to lend more. Sometimes big players expect things to work out poorly, and that causes them to compete for drive up the price of dollars (as they would drive up the price of GameStop) in order to cut their risks. Guesses about what others will do can play a key role here, which is part of why the result is hard to predict.
One somewhat unique feature of modern currencies is that central banks are at least nominally able to supply unlimited quantities of them, and there are widespread expert opinions that they out to do roughly that when the value of the currency is being bid up (i.e. when there’s deflation). There’s some sign of a trend towards central banks doing better at that. But it’s still not obvious what’s preventing them from doing better. (This is mostly relevant to standard recessions, which are caused by an unexpected decline in the inflation rate; some debts can’t be handled by stabilizing the currency, so I’m a bit hesitant to accept your broad framing of the term debt crises).
This is a great frame, thanks.
In the ending parenthetical, it sounds like you’re saying that I’m overapplying the term “debt crisis” compared to “standard recession” because what-you-would-call-a-standard-recession is caused by a quick decline in inflation, whereas what-you-would-call-a-debt-crisis is merely sparked by or correlated with a quick decline in inflation and is sometimes inflationary. Is that a correct paraphrase?
I will think about that claim more, but for now your frame seems very compatible with mine to me. My current reconciliation would say that your frame is more elegant for describing how the liquidity crunch works (just like a short squeeze on cash once people start bidding it up as they trade in debt, with an emphasis on the primacy of other actors’ reactions), but that it doesn’t really capture how you get to that vulnerable point, which is usually not by huge inflation moves but via the debt/credit cycle and some bad debts that take a bunch of cash out of the economy at once.
That paraphrase is mostly good. I’m trying to separate monetary phenomena, which are the main problem in recessions, from reckless debt levels, which are the main contributor to government debt crises.
Yes, my explanation is mostly compatible with yours.
I didn’t try to explain how a system becomes vulnerable. I think that happens via recency bias causing misjudgments, plus competitive pressures that Romeo mentions.